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MACROECONOMICSAND THE GLOBAL BUSINESS ENVIRONMENT

The Wealth of NationsThe Supply Side

Copyright © 2005 John Wiley & Sons, Inc. All rights reserved.PowerPoint by Beth Ingram adapted by R Helg

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Key Concepts

GDP GrowthTotal outputOutput per capita

Elements of GrowthLaborCapitalTotal Factor Productivity

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The Importance of Economic Growth

"No society can surely be flourishing and happy, of which the far greater part of the

members are poor and miserable." --Adam Smith

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GDP Growth

An increase over time in the quantity of goods and services produced by an economyRate of growth

Real GDP: adjusts for inflationReal GDP per capita: adjusts for size of population

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World GDP per capita:the capitalist economic system at work

World GDP per capita(1990 International Geary-Khamis dollars)

0

1 000

2 000

3 000

4 000

5 000

6 000

1 1000 1500 1600 1700 1820 1900 2000

Source: Angus Maddison, Historical Statistics for the World Economy

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Regional GDP per capita

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GDP per capita: Europe vs. Chinathey are coming back!

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Aggregate Real GDP

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Real per capita GDP

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Aggregate Real GDP

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Real per capita GDP

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Real GDP per capita, Top TenPPP US $

$0

$5,000

$10,000

$15,000

$20,000

$25,000

$30,000

$35,000

$40,000

Nor

way

Irela

nd

Uni

ted

Sta

tes

Den

mar

k

Sw

itzer

land

Equ

ator

ial G

uine

a

Icel

and

Can

ada

Aus

tria

Net

herla

nds

Source: OECD, Author’s calculation

5

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Real GDP per capita, Bottom TenPPP US $

Source: OECD, Author’s calculation

$0

$100

$200

$300

$400

$500

$600

$700

$800

$900

Zam

bia

Nig

er

Eth

iopi

a

Mad

agas

car

Gui

nea-

Bis

sau

Con

go, D

em.

Rep

. of t

he

Bur

undi

Tanz

ania

, U.

Rep

. of

Mal

awi

Sie

rra L

eone

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Importance of Growth

Growing population

Improving standards of livingGDP per capitaLife expectancyPoverty reduction

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Growing population

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Improves standards of living

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Life expectancy

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Poverty reduction: monetary poverty

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Poverty reduction: non-monetary poverty

1870 1913 1950 1995 Australasia 0.539 0.784 0.856 0.933 North America 0.462 0.729 0.864 0.945 Western Europe 0.374 0.606 0.789 0.933 Eastern Europe 0.278 0.634 0.786 Latin America 0.236 0.442 0.802 Eastern Asia 0.306 0.746 China 0.159 0.650 Sourth Asia 0.055 0.166 0.449 Africa 0.181 0.435

Source: Crafts (2000)

Human Development Index for geographic areas (weighted average)

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Growth, poverty and inequality

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Inequality and Growth: no systematic relationship

0.20

0.30

0.40

0.50

0.60

0.70

0.80

-10 -5 0 5 10 15 20

Growth Rate

Mor

e In

equa

lity →

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World income inequality

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

18201850

18701890

19101929

19501960

19701980

1992

Within group inequality Between group inequality Total inequality

source: Bourguignon-Morrison

World Income Inequality 1: the long run (mean logarithmic deviation)

Continuously increased between 1820 and 1980.Between 1820 and 1930 within country inequality has been the most important component of world income inequality.After 1930 the leading component has become across country inequality.

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World income inequality

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1970

1971

1972

1973

1974

1975

1976

1977

1978

1979

1980

1981

1982

1983

1984

1985

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

Within group inequality Betw een group inequality Total inequality

source: Sala-i-Martin (2002)

World Income Inequality 2: the last 30 years (mean logarithmic deviation)

After 1980 world income inequality has inverted its trend and started reducing. Mainly due to the fast convergence in per capita income between China (from 1980) and India (from 1990), on one side, and the developed countries, on the other.Note also the increase in the role played by within country inequality.

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1999 GDP per capita

(US = $30600)

Years to attain US 1999 level Actual growth

rate (1990-99)

1% growth 3% growth 6% growth 9% growth

Germany $25350 20 years 7 years 4 years 3 years 1.5%

UK $22640 32 years 11 years 6 years 4 years 2.1%

Brazil $4420 196 years 66 years 34 years 23 years 1.7%

China $780 370 years 145 years 64 years 44 years 9.8%

Ethiopia $100 577 years 194 years 99 years 67 years 2.2%

Compounding is a wonderful thing…

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Analysis of Growth

Capital(buildings,

infrastructure and machines)

Capital(buildings,

infrastructure and machines)

Total Factor Productivity

(technological knowledge

and efficiency)

Total Factor Productivity

(technological knowledge

and efficiency)Output (GDP)Output (GDP)

Labour(Hours worked, number

of workers)

Labour(Hours worked, number

of workers)

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GDP per capita: decomposition

GDP per capita =GDP

Population

GDP Hours Number Employed Labor ForceHours Number Employed Labor Force Population

= × × ×

Labor ProductivityLabor Productivity

Average Hours WorkedAverage Hours WorkedEmployment RateEmployment Rate Labor Force

Participation RateLabor Force

Participation Rate

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GDP per capita: decomposition

Labor productivityAverage hours workedEmployment rate = 1 – Unemployment RateLabor force participation rate

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GDP per capita decomposition

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Role of Inputs

More inputs means more outputDiminishing returns

1 worker = $10 in output2 workers = $18 in output3 workers = $24 in output

Marginal return is$8 in outputMarginal return is $6 in output

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Production Function

Output = TFP × Capital Stocka × Labor Hours(1-a)

Real GDP

Total Factor Productivity

A parameter (a number, 0 < a < 1)

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Cobb-Douglas example

0100200300400500600700800900

1000

0 500 1000 1500 2000 2500

Rea

l GD

P

Hours worked

TFP = 1Capital = 500a=0.6

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0100200300400500600700800900

1000

0 500 1000 1500 2000 2500

Hours Worked

Rea

l GD

P

0.6 0.4(500) (Labor Hours)Output = ×

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0

200400

600

8001000

1200

14001600

1800

0 500 1000 1500 2000 2500

Capital Stock

Output

0.6 0.4(Capital Stock) (1000)Output = ×

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Implications for labor productivity

Output = TFP × Capital Stocka × Labour Hours(1-a)

Labor Productivity

aGDP CapitalTFP

Labor Hours Labor Hours⎛ ⎞

= ×⎜ ⎟⎝ ⎠

Production function in intensive form:

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Changes in Labor Productivity

Total Factor ProductivityCapital per Labor Hour

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Capital Stock per labor hour

Labo

r Pro

duct

ivity

500 1000

8

12

Labor Productivity = TFP × (Capital Stock/Labor Hours)a

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Output Growth

% GDP per capita = % Labor ProductivityΔ Δ

And:

% Labor Productivity = % TFP % CapitalaLabor Hour

⎛ ⎞Δ Δ + × Δ ⎜ ⎟

⎝ ⎠

Assuming hours worked per capita constant we have:

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Capital Stock per Labor Hour

Labor Productivity

k1

y1

y2

Output/Labor Hour = TFP × (Capital/Labor Hour)a

Increase in TFP

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Growth in Output

Increase in labor supplyMay have no impact on GDP per capitaNot sustainable

Increase in capital stockMust increase at faster rate than labor

Increase in TFPNo diminishing returns in this framework

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Case study 1:

The relative slow rate of growth of the European economy if compared to that of the US especially after the second half of the ’90s.

Economic growth: case study 1

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Economic growth

After the WW II Europe converged to the US both in terms of GDP per capita and in terms of labour productivity (= GDP per hour worked).

This catching-up pattern experienced two major breaks in the last 30 years:

- Break 1: GDP per capita convergence ended after 1975

- Break 2: labour productivity convergence was reversed after 1995

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Economic growth

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There are two different interpretations of this:

a) The glass is half empty (Sapir Report)

b) The glass is half full (Blanchard)

Economic growth

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Economic growth- Half empty

UE experienced:

strong convergence in GDP per capita for 2 decades and a half weak convergence in the ’70s

divergence after the first half of the ’90s

EU GDP in 1970 and in 2000 is approximatively the 70% of the US one

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Economic growthHalf full

This is true, but it is valid only for output per capita.

The picture is much less negative when we consider output per hour worked: EU is approx 90% of the US one.

The difference is due to the fact that European employees work less hours during the year.

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Economic growth

GDP per capita growth = Hourly labour productivity growth + Hour worked per capita growth

The difference is due to the fact the European employee work a smaller number of hours per year wrt to US citizens.

Δ%(GDP/Pop) =

= Δ%(GDP/Hours) + Δ%(Hours/Pop)

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Economic growth

Half full (continues)

for example, between 1970 and 2000 the number of hours worked per person decreased by 23% in France and increased by 26% in the US

The Europeans have “decided” to increase leisure rather than income…

But this is not the only explanation available

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GDP per capita: expanded decomposition

Labour Productivity(b)

Labour Productivity(b)

Average Hours Worked(d)

Average Hours Worked(d)

1-Unemployment Rate(e)

1-Unemployment Rate(e)

Labour ForceParticipation Rate

(f)

Labour ForceParticipation Rate

(f)

GDP/Pop = (GDP/Hours)* (Hours/Pop) =

(g)(g)

(a)(a)

PopPop..

PopLab.Force..

Lab.ForceN.Empl..

N.Empl.Hours..

HoursGDP. 6415

6415

−

−

∗∗∗∗=

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Economic growthBlanchard’s explanation focus on the second term on the right (however, it’s decline explains only one third of the decline hoursper capita)

Other explanations:Prescott (2004): all decline in hours per capita was caused byhigher labour taxes in Europe

Ljungqvist-Sargent (2006): European welfare system increasesunemployment and reduces labour force partecipation

Alesina, Glaeser, Sacerdote (2006): decline in hours is mainly due to the political pressure by trade unions and left-wing parties toreduce hours and lower the retirement age

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Economic growth

But in the last 10 years European performance in terms of hourly labour productivity has not been good …….

…..probably because of the slower diffusion of information technologies

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Labour Productivity (GDP per hour worked) in 1999 US$

28

30

32

34

36

38

40

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

European Union United S tates

Economic growthsource: Ark (2004)

-4%

-10%

-5%

-8%

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3-52 Case study 2:

Growth accounting for Japan, Germany, the UK, and the United States, 1913–1950.

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Growth accounting for Japan, Germany, the UK, and the United States, 1950–1973.

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Growth accounting for Japan, Germany, the UK, and the United States, 1973–1992.

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Europe and Asia

Total Output:

Of Which

Capital Labor TFPGolden Age 1950-73France 5.0% 1.6% 0.3% 3.1%UK 3.0% 1.6% 0.2% 1.2%W. Germany 6.0% 2.2% 0.5% 3.3%Asian Miracle 1960-94

China 6.8% 2.3% 1.9% 2.6%Hong Kong 7.3% 2.8% 2.1% 2.4%Indonesia 5.6% 2.9% 1.9% 0.8%Korea 8.3% 4.3% 2.5% 1.5%Thailand 7.5% 3.7% 2.0% 1.8%Singapore 8.5% 4.4% 2.2% 1.5%

Europe relied on capital and TFP – Asian countries have relied on capital

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Growth Accounting

JapanCapital growth important through outLabor, TFP important ’50 – ’73

USTFP important until ’73Labor important after ’73

UK and Germany rely less on labor

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Growth AccountingAsian Tigers, 1966 - 1990

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Growth accounting in emerging markets, 1960–1994.

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Summary

Importance of GrowthSources of Growth

GDP per capitaHourly productivityNumber of hours worked

ProductivityCapital AccumulationTFP

Growth Accounting

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